The gap between initial funding and firms shutting down has increased and with overall funding dropping Michael Zammuto says

The Wall Street Journal Reports the rapid rise and now retreat of venture funding and the gap this is creating for ‘A’ round funded companies to access more capital.

to expect a massive increase in failures in 2017 and 2018. From 2010 to 2015 the number of companies receiving early stage angel and ‘A’ round investments climbed dramatically. Market forces, tech trends contributed but so too did some concerted efforts to make it easier to form a tech fund. Everything from Amazon Web Services (AWS) to shared workspaces, to better smart phones to better development tools all contributed to lowering the barrier to entry for startups.

As published online today, Michael Zammuto explains the the unintended consequence of this is that those startups did not get access to more VC governance or talent (or luck). Overall funding has started to drop and the gap for later stage, ‘B’ round investments has gotten large to a concerning degree. This creates a special challenge for startups to stand out and demonstrate why they deserve more capital.

To offset this increased challenge, Cloud Commerce suggests reviewing your strategy well before you need to raise money, to start raising money earlier and ask for more. Critical to ‘B’ round funding it to ‘prove’ that the core assumption about how the business will scale is demonstrated, even on a small scale. If you depend upon network effect, or cheap content or clients upselling then focus on optimizing for that metric. Don’t spend unnecessary capital on product enhancements, focus instead on proving you have the model right and just need capital to hit your multi-year projections. You should expect that your ‘B’ round will be more difficult to complete and you have a business to run so get help and stay focused on proving your story.

As mentioned in this LinkedIn post, ‘B’ round fundraising is getting more difficult in 2017 and may stay that way for some time. Starting several years ago, a number of innovations came together to make startups cheaper faster and easier to get off the ground. There are actually a lot of contributing elements. the Journal of Financial Economics report focuses on AWS and certainly cloud services and cloud infrastructure have helped a lot of startups get from concept to beta very quickly. I would add a lot of other things to the list including shared work spaces, freelancer networks, angel investing and kick starter funding platforms and even improved mobile communications and productivity apps.

All these things did cause an increase in Angel funding and that also led to more ‘A’ round candidates and funding. More ‘A’ round funding has not led to more success. Venture firms are not increasing staff along with the increase in early stage funding so their early stage investments are getting less governance and attention. So, at least so far, this has led to more failures and harder ‘B’ round fundraising. Cloud Commerce Consulting is here to help in this process and can position early stage companies to demonstrate the progress and market traction needed to warrant closing that critical ‘B’ round.

About the author

Michael Zammuto heads the company advisory services

Michael Zammuto is the founder and CEO of Cloud Commerce Consulting. He has helped 6 startups achieve profitability, been involved in six exits and major fundraising rounds. He is an adviser to several companies. He also currently servers as Chief Executive of Completed.com. Zammuto was the CEO of Brand.com and Sapago and was President of Chaikin Analytics and Chacha.com. Zammuto also served as COO of Ontario Systems and was a senior executive with Ecometry Corp. before the acquisition by Golden Gate Capital. Mike’s full profile can be read here.

Founding CEOs and board members should consider how the founder’s role may change over time and when and how to bring on an outside CEO vs. a COO or president reporting to the founder.

Rapidly changing startups and growth firms need very different leadership skills and operating models at different stages

Issues of trust and control must not limit implementing the right leadership for the firm

Never approve an annual plan and budget without addressing the evolving leadership needs

The founder should do what they are best at and the CEO should be the best person for that job even

Every firm needs expert general management but many founders are functional experts who tend to add other functional executives

COOs or presidents can be ‘executers,’ ‘change agents’ or ‘foils’ to the founder

An interim CEO or COO can help to navigate these critical decisions and smooth transitions

The founder’s role and actions after hiring a CEO or a COO is critical to the success of that new executive

Nobody personifies a company the founders. Founders have a deep, emotional connection with their startup and with their role as CEO. Founders are concerned with achieving their vision and maintaining control and they have skills and experience that can be impossible to find elsewhere. But, this unique relationship with the business prevents some founders from making the right decisions about the rapidly changing senior leadership needs of the company.

The operating model in the combination of company departmental structure and how it creates value and services customers. This involves all major processes and norms that direct development and production, how decisions are made, performance management, management KPIs, etc, etc, etc. Most failures of execution reflect problems with the operating model. What worked pre-revenue or at $ 1M, $ 10M or $ 25M revenue often fails miserably at other company stages.

Consistently we see that a critical leading indicator of the success of a firm is the evolution of the operating model. The CEO owns this and sometimes delegates management to an operational expert. Founders that don’t ensure the operating model aligns with company stage and strategy will underperform those who do and risk the venture. Except for scandals, this is the root cause of most founders who are forced out of their company.

The basic strategies for a founder include…

Stays CEO but get help

Hire a CEO and exit the company

Hire a CEO and take a role senior to the CEO

Hire a CEO and take a role reporting to the CEO

Founders should focus on their unique skills

Most founders are fantastic entrepreneurs and usually functional experts with deep domain expertise and they may be gifted company evangelists or technical, sales or product experts, for example. When a firm is small and immature they rightly fill many different roles but still make time to do that thing that they are uniquely qualified to do.

Few founders are also great generalists with experience scaling an organization. One common situation is a firm that has two founders where one is a technical or product whiz and the second is an expert is sales or marketing. The incorrect assumption is that those are the two things that drive their business so they can run everything until the company gets large or profitable enough for functional leads to take on less critical departments. This model works well in the earliest stages but falls apart under complexity because nobody owns the operating model and the founders must choose between doing what they love and running the business as chief executive. The founders’ time is not only valuable, but expensive to the firm if it is not yielding maximum growth.

Determine who are the best people to ensure success going forward. What MUST happen in 2017 to exceed your goals? Think about the linkages between departments and initiatives. Are you working to drive hockey stick growth? Replatform your successful technology? Enter new markets? Determine if the founder is the best person with the optimal mix of skills and the energy to succeed.

Stay CEO But Get Help

There are two main things to consider with this strategy. First, is it temporary or long-term and second do you need functional expertise or broader general expertise (or both). There are a lot of options here. These include building out/up your senior team first with functional experts (CFO, CTO, product exec, etc. who’s scope is narrow on a single business discipline) or general managers (GM, COO, president, etc. who work at broader scope and P&L responsibility).

Founders often hire functional leaders when what is really needed is a generalist to address the evolving operating model. This frequently leads to revolving doors of frustrated, failed executives. A top-notch generalist often has the functional expertise to lead multiple areas and is better at ensuring that each area has what they need for everyone to succeed. For smaller teams, functional executives are usually the wrong first step. One growing startup hired a VP sales from IBM who has a $ 1B annual sales number and was used to managing other VPs and teams of hundreds. The sales VP brought new sales talent, processes, tools, etc but interdepartmental issues involving cultural, communications, morale, performance management, strategy misalignment, product/marketing mismatches, etc. ensured he couldn’t take ownership of his success. He butted heads with the rest of the organization and was gone in 4 months, blaming the founder and the rest of the company not supporting sales and delivering. In this case, hiring a functional expert brought to the surface that the founder-led firm was unprepared to support the new exec.

Generally, I advise against startups and maturing growth companies from hiring functional executives to grow into general management role, especially the CEO job. That requires too many things to go right. Most functional executives will never transition to senior level general management roles. That transition requires a lot of mentoring, time and a special breed of executive. You may think that hiring a new, awesome VP means she is the natural successor but think about the transitions. That person must join you and learn your company, often learn new offerings, new markets or segments, do a critical job while learning the broad range of skills to be a great general manager. This will take years and startups/growth firms change too much in a few years to plan for it. Hire people for the job you need them to do today.

Below are three ‘flavors’ of COO that are most valuable to CEOs of startup and growth stage companies. COOs should drive growth and strategic initiatives. Never hire a COO whose chief skill is process improvements, auditing or governance unless you are in a business and at a scale where that is what is really required.

The Executer: this COO adds value through better execution and by freeing the founders and CEO to focus on adding maximum strategic value.

The Change Agent: Change is a constant but also something that gets harder as organizations age and grow. Founders shouldn’t risk learning to manage change on the job when there are experts in this field.

The Foil: provides someone to be what the founders and CEO can’t be. This varies but where one is outward looking the other can be inward looking, good cop/bad cop, detail oriented/big picture, intuitive/data driven, etc.

I created COO roles at companies using each of these flavors. In each case, the startup dramatically increased growth and their first profits within a year and the founder was happier and more productive. The right second-in-command can be transformative if there is mutual trust and the roles are structured to bring the best out of everyone.

Hire an Outside CEO and take a new role

Larry Page and Sergey Brin knew that Google’s success depended upon them ensuring Google was the top innovator in online search advertising. Adding Eric Schmidt as CEO demonstrated maturity and while helping their venture investors to take a longer and bigger view of success.

An outside CEO can be a powerful option but must be managed right or you risk undermining the new CEO and hurting the firm instead of moving it forward. Get someone who is experienced creating the role for scratch and working with founders.

This decision means the new CEO is the chief executive and the founder needs to make it crystal clear in words and actions that is what is happening. If the founder is going to de-facto stay running the daily working of the firm, then do not hire someone into the CEO role. It will confuse and frustrate everyone and can be deeply damaging. A great COO, an internally focused president or a GM can have broad, cross functional authority and responsibility. Never give a title as important as CEO to someone as an honorarium when you don’t mean it. If the candidate isn’t happy being COO then don’t hire them. This isn’t just title inflation. It is not like giving your valued development manager a ‘director’ title when he directly manages one team. Misalignment between CEO title and role will do real harm. Hire someone who will want the role as it is detailed. Never dangle the CEO title as a way of getting someone to take a COO role if you are not willing to stick to strict timelines and achievable milestones. That isn’t a viable strategy and will destroy trust.

If the founder plans to take a functional role to focus on those things the they do best (like product, technology or sales) but will also be chairman you can make this work but it is the trickiest of all situations. A chairman is the head of the board and the board is the CEO’s boss. A CEO will be right to be concerned that one functional lead of the business is their boss.

For this to work the CEO and the founder need to put their egos aside completely. The founder needs to feel secure and that the CEO and board are aligned with the plan. The founder and new CEO need to stay in regular contact and discuss and debate issues privately and the founder needs to constantly reinforce publicly that the CEO is the boss. This means the founder must never allow people to come to them to settle their gripes with the CEO or to appeal a decision. Allowing that even once, when wrongdoing isn’t involved, will send contradictory messages and do immeasurable harm.

Transitioning from founding CEO to chairman is a good option if the founder cannot be involved with operations but wants or needs to continue to own the investor and board relationships. The founder needs to be mindful that their board responsibilities as chairman are very different than as CEO. This is a good role for pure external evangelists too. If you do this, give the CEO space and stop coming to the office all the time. Don’t second guess and don’t get involved. This will be uncomfortable but if it isn’t a board issue then keep out of it or discuss it with the CEO behind closed doors.

The founder’s impact on the business is truly unique but they may not always be the best choice for CEO. Ideas and markets are great but a company will never outperform the abilities of its people. There are several options for how to address this. Carefully consider the best role for the founder and make sure you have the senior level talent to take your firm to the next level.

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